Things to keep in mind when it comes to capital gains tax exemption

Finance guru Noel Whittaker answers your money questions and highlights ways to maintain the capital gains tax exemption. Picture: shutterstock
Finance guru Noel Whittaker answers your money questions and highlights ways to maintain the capital gains tax exemption. Picture: shutterstock

This week I received an email from a reader with an issue that continues to baffle people.

He wrote that he and his wife have lived in their present home for 10 years and have heard they can be absent for up to six years without losing the capital gains tax exemption.

But he wondered about the position when a person moved into a new home, and rented out the original one.

He asked if they can they nominate which is their principal place of residence, and also what address to put on their annual tax return.

It is correct that you can be absent from your residence and live in another home, you own, without losing the CGT exception.

If the property is being used to produce income then the period of absence is limited to six years, for the full exemption, though setting up home there again means another six years when you move out.

For those who like history, the six years came about because that just happens to be the term for a politician in the Senate.

This law enables politician to move to Canberra for six years without losing the CGT exemption on their home then come home for a while to fight an election then rent out their home for another six years.

If the property is not being used to produce income, the period of time it can continue to be covered by your main residence exemption is infinite.

It gets a bit tricky when you move out of a residence, and start to live in another one and treat that as your new residence.

The good news is, that you don't need to elect which home is your principal residence, until you decide to sell one of them. This may be several years down the track. It is important to keep receipts for expenses relating to both properties to keep your options open.

Anything to do with the property that has not otherwise been claimed as a tax deduction has potential such as interest, rates, repairs, insurance and improvements. But also consider every day expenses such as cleaning materials, light globes, lawn mower fuel etc.

Furthermore, if you do decide to treat the new home as your residence, you are only liable for CGT on the original home, on the gain, from the date you rented it out.

This is why it's important to get a valuation on that property when you move out of it. This resetting of the cost base to market value does not apply if you do not use it to produce income.

Let's look at an example. You own a property, which is worth $600,000 when you move to a new residence which costs $800,000.

In five years, the original property is worth $700,000 and the new residence is worth $1.2 million. There are no decisions to make until you are thinking about selling one.

But let's suppose you've decided to keep the rental property, because you are now downsizing to a retirement village.

After talking to your accountant, you will probably decide to nominate your present residence as your principal residence, leaving an unrealised capital gain on the original property on which no CGT will be payable until the property is sold.

The address for tax return purposes is the actual address of the place you are living in. That makes no difference to the CGT position but it is important that you retain evidence that you lived at both places at some time.

There is one exception to the rule which can be utilised by savvy investors. If a property is your principle residence at the date of death, any previous CGT liability can be avoided.

Suppose a person owned their own home, and also an investment property that was carrying a high unrealised capital gain. If they felt they were close to death, they could sell their current residence and move into the investment property and treat it as their own home.

At date of their death, it would be their residence and would be deemed to be acquired by the beneficiaries at its market value at date of death. The property could then be sold by the beneficiaries CGT free within two years.

Noel answers your money questions

Question:

In an article about Death Tax payable by Non-Dependents you said, "in a high trust situation", you might plan for an attorney to withdraw an entire super balance if a member appears close to death and the proceeds deposited into the member's bank account.

If the only account is a joint account, a clause permitting this should be inserted in the Power of Attorney document. Under what circumstances would this not be possible, does that type of clause have a name, and can this be done after death?

Answer:

The usual circumstance where this may not happen is where the Superannuation Fund refuses to pay out the death benefit even on the valid request of an Enduring Power of Attorney or where the funds are directed to go into an account, not of the member. That's why it can be important when doing your Enduring Power of Attorney, to insert a special provision authorising your Enduring Power of Attorney to withdraw the funds only after obtaining proper financial advice and deposit them to the member's bank account.

The attorney would not be permitted to deposit the funds into their own bank account or anyone else's. It's called a conflict of interest. The withdrawal of super to achieve the benefits I have discussed is not effective after death, only before death. If it is done after death, the normal tax rules will apply.

Question:

We are aged in our late 70s and in 2007 my wife and I purchased a house for our daughter. It was registered in our names and that of our daughter in three equal shares.

Our daughter has always lived in it rent free. We now propose to transfer it to her as a gift. Our problem is we have to pay Capital Gains Tax.

Recently you wrote that as we have not received any income from the property we could add all council rates to reduce the CGT. What other expenses could we add to further reduce CGT? The hot water service and the air conditioner have been replaced and reticulated gas has been connected. Any advice would be gratefully appreciated.

Answer:

As the property was acquired after 20 August 1991, and it has never produced income, you are entitled to add all expenditure to the base cost when calculating capital gains tax.

This includes rates, land tax, insurance, electricity and even things like replacing light bulbs. This is why it is important to keep good records.

Your situation also serves as a warning to readers of the dangers of helping children buy a home by becoming a co-owner.

There are other ways you could have helped without putting your name on the title, in which case there would be no CGT to pay as the property would never need to be transferred to the child.

  • Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance - noel@noelwhittaker.com.au
This story Navigating the issue of capital gains tax exemption first appeared on The Canberra Times.